November 28, 2008
Pakistan’s Economic Challenge
Since Shaukat Aziz left office over a year ago, Pakistan has seen tremendous economic turmoil. Flour shortages, massive load shedding, galloping inflation, rupee devaluation, the crash and subsequent closure of the stock market, a President having to go on a global begging mission, a surge and then collapse of commodity prices, a run on foreign exchange reserves, all culminating in a return to the warm embrace of the IMF, as Pakistan asks for 7.5 billion dollars to keep the economy afloat. Where does Pakistan go from here, and can we expect a return to the stable and consistent growth of the Musharraf era?
There is some good news. The global slowdown has at least brought commodity prices back to Earth. Crude oil is under 60 dollars, and trading where it was at the start of 2007. The big run in other commodities, especially wheat and rice, has completely deflated, with prices back to the pre-surge levels of early 2007. This should have the effect of dampening inflationary pressures in Pakistan, as much of it was driven by the global commodity surge. The fall in oil prices will also help reduce the trade deficit, as oil imports are a big part of Pakistan’s trade deficit. But to really get ahead of inflation, the central bank has to get real interest rates to be positive. Currently at 15%, money can be borrowed too easily, as core inflation is still 18%, and overall inflation is above 20%.
A panel of economists on behalf of the Planning Commission has just issued a program to achieve macroeconomic stability. It calls for significant austerity measures, including new taxes, a 10% reduction of the development budget, an elimination of new programs, a 30 billion rupee cut in defense spending, and further reductions in other government spending. The panel projects that unemployment will rise from 5.3% a year ago to 6.5%. They also project that economic growth will slow to 4.4% this year, before rebounding to 5.1% next year. This compares poorly with the 7% average of the previous five years.
Pakistan does not have much choice but to tighten its belt and reduce government spending. But make no mistake about what this means. Reduced spending means less resources for education and health and infrastructure. The slowing of growth is also very undesirable. There is no such thing as poverty reduction without rapid economic growth. There are some critics of Musharraf who indulged in a fantasy that high growth is bad and low growth (if it can be made sufficiently “pro-poor”) is good. This is muddle-headed thinking at its worst. Pakistan is a poor country, and it can only become rich by rapidly increasing the amount of goods and services it produces, in other words, by rapid economic growth. Such growth results in rising wages, increased demand for labor, increased government revenues, and increased spending on development.
It is vitally important that rapid growth be restored to the economy. It will probably take one-two years of adjustment to fix the current mess and resume the path we were on. There are however several things that could prevent that.
First, of course, are the politicians. If they resume their previous ways of massive and distorting levels of corruption, which sapped the economy in the 1990’s, then the economy will remain prostrate. But Pakistan is a more sophisticated place now than it was then. Hopefully, between the media and the business class, there will be sufficient pressure to prevent a return to that.
The second risk is related, namely, that the government abandons the basic economic framework created by Aziz. So far there is little evidence that the current government wants to make any significant moves. In fact, the economists of the Planning Commission formally recommended the current Parliament recommit to the Debt Reduction Framework that Aziz put in place. The other principal changes, particularly the privatization of the banks and the opening of the trade and foreign direct investment sectors, seem likely to be retained. The government released a list of its privatization goals for the next two years a few weeks ago, and it was a very impressive list of the major companies still in government hands, including PSO and PIA among others. But will they have the political will to actually carry through this wish list?
The final risk to Pakistan is terrorism and extremism. Initially, the current government was rather unsure of what direction to take, with some forlorn hope of a political accommodation with Pakistani Taliban and Jihadis, along with perhaps some continued ability to influence Afghanistan’s internal politics. These fantasies have come crashing down, as such hopes only resulted in more suicide bombings and a collision course with the United States, which sees no legitimacy to Pakistan supporting a Taliban insurgency from its soil. If Pakistan continued along these lines, there was a real danger of a breakdown of state authority domestically, and a complete rupture with the US internationally with devastating consequences. Fortunately, Pakistan has stepped back from such a suicidal course, and both the government and opposition have voted unanimously to defeat the extremists by force if necessary. The army has now taken badly needed action with real vigor. Hopefully it will not be a case of too little, too late.
Despite all the recent turmoil, Pakistan retains some solid strengths. Living standards are higher in Pakistan than India or Bangladesh. Remittance flows are strong, and there is a reasonable industrial base built up over the last decade to expand on. If the government can resolve the medium-term problems, and restore long-term growth at 7%, they will not only improve the lives of average people, they will also consolidate the legitimacy of democratic governance in Pakistan.
Comments can reach me at nali@socal.rr.com.
